Section of Taxation Publications
  VOL. 53
NO. 4
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 Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
 Interest Allocation: A Regime Desperately in Need of Sound Policy
Bret Wells*

* Latin American General Tax Counsel, Cargill, Inc., Minneapolis, Minnesota; Southwestern University, B.B.A., 1987; University of Texas School of Law, J.D., 1989.


On August 5, 1999, Congress passed H.R. 2488, the “Taxpayer Refund and Relief Act of 1999.” Section 901 of H.R. 2488 would substantially modify how U.S. taxpayers allocate interest expense between U.S. and foreign source income using a worldwide fungibility approach. This provision is intended to rewrite the current interest allocation rules set forth in section 864(e) of the Code. From its inception, section 864(e) was intended to be a revenue raising provision with no pretense of being based on sound policy. As such, it has created substantial mischief. Congress has known for years that section 864(e) is pernicious but has been unsuccessful in building enough support to amend this provision.

However, although section 864(e) is flawed, H.R. 2488’s worldwide fungibility approach swings the pendulum too far in favor of taxpayers. As expected, President Clinton vetoed H.R. 2488, and administration officials state that they are open to consider a worldwide fungibility approach to interest allocation only in the context of a broader proposal to reform the U.S. international tax rules. Notwithstanding this statement, reform of section 864(e) is complicated by the pragmatic politics of budget economics. The Congressional Budget Office projected that H.R. 2488’s amendment to section 864(e) would cost over $25 billion if implemented. Commentators speculate that an amendment to section 864(e) would only be acceptable to the President if the budget impact of such an amendment were significantly reduced. Thus, just like the political environment at the time section 864(e) was enacted, budget concerns, not sound tax policy, are taking center stage on the development of U.S. international tax policy. Congress and the President continue to find it difficult to fix a provision widely known to be flawed.

This paper argues that both section 864(e) and H.R. 2488 fail to achieve the dual objectives of protecting the U.S. taxing jurisdiction over U.S. domestic source income and preventing international double taxation. In critiquing these provisions, this paper sets forth an approach that seeks to balance these two competing, legitimate interests of U.S. tax policy.


Published by
Section of Taxation, American Bar Association
With the Assistance of
Georgetown University Law Center


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